Retail FX Margin Trading

August 2007

Hjalmar Schröder / Reto Stadelmann

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FXCG_RetailFX.ppt

Agenda for today

What is Retail FX Margin Trading ?1

Size and Growth of Retail FX2

Views on trends in Retail FX and their Implications 3

Summary of Points for Take-Away4

SECTION 1

What is Retail FX Margin Trading ?

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FXCG_RetailFX.ppt

Retail Investors in FX

♦Retail participation in the FX markets has so far mainly been a by-product of other activities such travel, credit card purchases and cross border equity investment.

♦Now Retail Clients can actively trade FX as an asset class on similar prices that wholesale clients get.

♦Retail Aggregators, acting as intermediary between retail clients and larger foreign exchange dealers have brought the FX asset class within the reach of retail clients. The pioneers of Retail FX (e.g. OANDA, FXCM, GAIN, SAXO etc.) are independent firms, who have quickly built a credible offering in a segment outside of traditional banks’ coverage models.

♦Retail FX is growing at about 30% per year, helped by the rapid growth in affluent and high net worth individuals, especially in Asia, where Retail FX Margin Trading is particularly popular.

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FXCG_RetailFX.ppt

Key Features of Retail FX Margin Trading

Real-time margining and automated close-out

Cash-for-Difference instead of Settlement

♦ Platforms offer leverage between 1:20 and 1:200

♦ Dealing and Limit Orders♦ News♦ Charting♦ Overview of PnL and Positions

♦ No foreign currency accounts held for clients♦ Automatic roll-over of positions♦ Automatic PnL Conversion

♦ Spreads are only slightly wider than on wholesale platforms (e.g. EUR/USD typically between 1 and 2 pips)

♦ Spread on rolls still rather wide

♦ Some platforms focus on FX Spot only♦ Others offer options and forward outrights

or future-look-a-likes♦ Trend towards cross-asset offerings

Integrated Workbench

Competitive Spot Spreads Different Product Ranges

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FXCG_RetailFX.ppt

Example of a Retail FX Screen

Section 2

Size and Growth of Retail FX

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FXCG_RetailFX.ppt

How big is Retail FX? – At first and second glance ...

♦ Average daily Retail FX Volume is estimated around $50 bio

♦ At first glance Retail FX seems small at only 2% of the $2’000+ bio global FX market

♦ Taking into account that about two thirds of the global FX volume are Swaps and that about 50% of the remaining Spot volume is interbank trading, the more relevant daily buy-side spot volume is about 300-400 bio, of which retail is more than 10%!

♦ A lot of Retail FX volume is concentrated in “carry pairs” such as AUD/JPY, NZD/JPY etc. and there is anecdotal evidence that Retail flow had a significant impact on price action in those pairs over the last months.

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FXCG_RetailFX.ppt

Example of Retail Aggregator Growth

♦ Recent average annual volume growth is pretty stable at 30% per annum

♦ Increasing number of high-end retail clients

♦ Stable to slightly increasing ticket size

♦ Client burn-out rate stable over last couple of years (but this varies across different platforms in the market)

Growth of a Major Retail Aggregator

0

100,000

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2001

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$ m

io

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# Ti

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USD Volume # Tickets

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FXCG_RetailFX.ppt

How Retail is Retail?

♦ More and more “Retail” clients reach well into wholesale territory in terms of trade and position sizes.

♦ Scientific studies by a retail aggregator show hardly any differences in trading styles between truly self-directed retail clients and professionals

Risk / Liquidity

♦ Clients of retail aggregators start connecting over APIs and trade algorithmically

♦ Demand for highly professional executing and charting tools

♦ Several platforms start to support managed accounts

Tools and Services

♦ Pricing difference between retail and wholesale e-FX diminishing rapidly (some institutional clients still trade on 2 pips EUR/USD rates ...)

♦ Provider firms still have pricing power on the rolls

Spreads

SECTION 3

Views on trends in Retail FX and their implications

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FXCG_RetailFX.ppt

Challenges for Retail Firms

High Service Requirements

♦ Large scale account openings

♦ Margin management on high leverage

♦ Risk and Position Information

♦ Day-to-day queries, increasing demands on execution quality

♦ High demands on scalability and stability of IT platform

♦ Credit Quality to attract larger customers

Low Margins

♦ Small tickets (e.g. OANDA alone has about 500’000 tickets a day, which is 3 times the EBS ticket volume)

♦ Tight spreads on all major currency pairs

♦ Competition to increase with big banks entering the market

Challenges for Retail Firms

♦ Highly efficient processes for client set-up, service and back-office

♦ Scalability of IT Infrastructure

♦ Making money from the flow, increasing risk management demands

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FXCG_RetailFX.ppt

Major Banks entering Retail FX (1)

Credit Rating / Risk Taking Capacity

Brand Strength, Footprint with High Net Worth Clients

Cross-Asset Capabilities

Value Proposition of Major Banks in Retail FX

Risk Management Experience

1

3

2

4

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FXCG_RetailFX.ppt

Retail FX – The next Mega-Trend in FX?

♦Will Major FX Banks change the Retail Market or will the Retail Market change them?

♦After the advent of electronic brokerage, e-Tools, API’s and anonymous buy-side access to markets, we think that Retail FX could well be the next big revolution in FX.

♦Retail FX will force players to a thorough re-engineering of systems and processes. Retail volumes will enforce simplicity and transparency in all processes along the value chain, from on boarding over order execution to margin management and settlement – and this will not remain limited to the retail side of the business.

EBS FX Trader B2B API’sAnonymousMarkets

Retail FX

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FXCG_RetailFX.ppt

How Retail FX could change the FX Market♦ In general scaling up to Retail Volumes will impose simplicity and

standardisation in

– Order execution (reference, protection, slippage).

– Client spreading

– Margin Management and Close-Out

♦ Increased usage of CFD-like products in the overall market – in the longer term time-weighted interest accrual as implemented by OANDA is likely to be an interesting option for the overall market

♦Strong IT requirements in terms of system availability and flawless pricing. A single price misprint can cause tens of thousands of spurious executions. Retail customers have no alternative channel during outages.

♦Self directed private clients are a new class of market participants, where direct relationship and interaction is very difficult for liquidity providers and regulators.

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FXCG_RetailFX.ppt

Current and Futures Landscape of FX Services and ProvidersFX Speculators FX “End Users”

Traditional Multi-Bank Portals / ECNs

Traditional Single Bank Platforms Ind

uced

FX(C

ross-B

ord

er Secu

rities, Paym

ents)

Listed FX Instruments

Retail FX Margin Trading

Retail A

gg

regato

rsM

ajor FX

Ban

ks

Traditional Multi-Bank Portals / ECNs

Traditional Single Bank Platforms

Ind

uced

FX(C

ross-B

ord

er Secu

rities, Paym

ents)

FX M

argin

Trad

ing

TOD

AY

FUTU

RE

Hig

h-En

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w-En

dH

igh

-End

Low

-End

Listed FX Instruments

♦Tech

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log

y-led en

trants

♦A

uto

mated

Marg

inin

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♦M

ulti-b

ank Pricin

g♦

Process Exp

ertise for R

etail V

olu

mes

♦R

isk Man

agem

ent

♦B

alance Sh

eet Cap

ability

♦W

ho

lesale Liqu

idity A

ccess♦

Process Exp

ertise for

ph

ysical settlemen

t

SECTION 4

Summary and Take-Away

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FXCG_RetailFX.ppt

Key Points for Take-Away

Retail FX accounts for around 10% of buy-side spot volume and is growing at about 30% a year

Rapid spread compression (but still some good margin on rolls)

Focus on Retail FX is likely to change the wholesale market too

Boundaries between Retail and Institutional FX are getting less clear

Entry of major FX banks will add further momentum to Retail FX

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FXCG_RetailFX.ppt

Further Reading

In addition to various UBS internal sources, the following materials have been used in this presentation:

♦ “Retail FX – Understanding the trend; leveraging the opportunity”, Client Knowledge, 2007

♦ “Taking the Client’s Perspective”, Boston Consulting Group, 2006

♦ “Commenting on Retail FX Market”, Federal Reserve Committee Letter, 2005

♦ Interview with Richard Olsen, Co-Founder of OANDA

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FXCG_RetailFX.ppt

Contacts

♦ Hjalmar SchröderHead MCC Pricing and e-Commercehjalmar.schroeder@ubs.comTel +41-44-2395814 / +41-79-6383400

♦ Reto StadelmannHead MCC Tradingreto.stadelmann@ubs.comTel +41-44-2396166

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FXCG_RetailFX.ppt

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